Last month, Dave Camp, the chairman of the House Ways and Means Committee, released a draft proposal to change how we tax certain types of businesses known as pass-throughs. ... Mr. Camp’s proposal includes two options.

The first option addresses
what we might think of as deferred maintenance — cleaning up some
corners of the tax code that have been neglected. For example, it would
relax the anachronistic eligibility restrictions for subchapter S
corporations. For partnerships, the proposal would repeal the confusing
rules related to “guaranteed payments.” It would also make some useful
changes to the partnership tax rules related to basis adjustments and
revise some outdated definitions.

The second option, a more radical one, appears to be a stalking
horse. This would replace our existing system with a unified set of
rules for pass-throughs. This sounds simple and appealing. Many of the
ideas in Option 2 are promising, but they are largely untested and not
fully explained in the proposal....

In my view, there’s an additional problem with Mr. Camp’s proposal: its
failure to address how the partnership tax rules are now being used, and
abused, by large businesses. The partnership tax rules were originally
created for small business, so a small number of individuals could work
in a business together and mix together labor and capital without having
to pay an extra layer of tax. The rules are now used in ways that
Congress never intended. Two examples are the erosion of the corporate
tax base and the tax treatment of carried interest. ...

Of course, Mr. Camp has pitched the proposal as being about
simplification of the tax rules for small business. Avoiding the topic
of carried interest is consistent with that message. But if Mr. Camp wants to raise some revenue to pay for tax changes
elsewhere, like a reduction in the corporate tax or a shift to a
territorial tax system, he will have to follow the money to where it
disappears — through loopholes like carried interest and the abuse of
the publicly traded partnership rules.

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Comments

If you want simple, taxing all entities as C corporations with some sort of integration mechanism to escape most double taxation is far simpler from a compliance perspective than any kind of pass through other than a disregarded single member entity. All business income gets taxed on one form and ownership transactions arise only when they actually take place. C corporations are troublesome in terms of substantive tax burden, but from a compliance perspective they are much less complex and the concepts are far more intuitive.

For example, the fundamental partnership and S corporation tax concept of separating the allocation of items of income and expense from the distribution of partnership property to partners is something that people who are not trained tax professionals to get their heads around even without the non-intuitive concept of a guaranteed payment. Informal partnership agreements are often drafted in ways that make this ambiguous. And, once you get into the nuances of non-recourse liabilities arising because the partnership taxed entity is a limited liability entity it can get absolutely Byzantine.